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Sunday, 29 November 2009

Dubai Debts Test Islamic Finance

CAIRO - As the world is still recovering from an economic meltdown, an unfolding debt crisis in the flashy lifestyle-Gulf state of Dubai is sending shockwaves around the world, putting the booming Islamic finance to a test.

“A Default by Dubai will put the world of Islamic finance to the test at a time when hard questions are being asked by bankers and lawyers about the protection afforded by financial instruments based on Shari`ah law,” commented The Australian on Saturday, November 28.

Dubai announced Wednesday that its state flagship conglomerate, Dubai World, wanted a six-month standstill on 59 billion dollars in debt.

The move has sent shockwaves across the world economic markets over fears of a debt default.

“The bond that is at the heart of the threat of default and financial ignominy for Dubai is the sukuk,” said The Australian.

There are concerns that Sukuk creditors may not be protected.

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It is not clear how creditors will rank in an insolvency, said Neale Downes, a Bahrain-resident partner at law firm Trowers & Hamlins.

He said investors sometimes have found themselves competing against other creditors rather than being able to enforce their claim on the underlying asset supporting the Sukuk.

Sukuks, which conform to Islam's prohibition of receiving or paying interest, typically work as profit-sharing vehicles.

Companies that issue Islamic bonds make payments to investors using profits from the underlying business, instead of paying interest.

But money can not be invested in alcohol, gambling, pornography, tobacco, weapons or pork.

The Sukuk market has reached $111.9 billion in the eight years to 2008 and a further $69 billion is expected to be issued in 2008/2009, according to the International Islamic Financial Market.

Islamic finance is one of the fastest growing sectors in the global financial industry.

Starting almost three decades ago, the Islamic banking industry has made substantial growth and attracted the attention of investors and bankers across the world.

A long list of international institutions, including Citigroup, HSBC and Deutsche Bank, are going into the Islamic banking business.

Currently, there are nearly 300 Islamic banks and financial institutions worldwide whose assets are predicted to grow to $1 trillion by 2013.

Bailout

Dubai debt problems have triggered fears of a new world economic crisis.

“If you look to government balance sheets around the world you’ll find plenty of potential banana skins,” Jim Reid, strategist at Deutsche Bank, told The Times.

“Given the nature of this crisis the probability of further sovereign events remains elevated.”

A financial firestorm swept the US and the world in September 2008, after the demise of Lehman Brothers, one of the Wall Street giants.

It has knocked down many major companies worldwide, causing mounting job losses, falling household wealth and forcing consumers to hold back on spending.

"Dubai is very much a reminder that the lingering effects of the credit bubble are still with us," Barry Knapp, of US equity investments at Barclays Capital, told The Washington Post.

"While there no real direct linkages to U.S. markets and our direct exposure is small, we have plenty of our own bad debts in the US"

Dubai is estimated to have total debts of $88 billion.

Investors have downplayed the gravity of Dubai problems, saying if worst came to worst, the emirate could be bailed out by Abu Dhabi, its oil-rich neighbour.

Abu Dhabi, the capital of the United Arab Emirates, has already said that it will “pick and choose” how to assist its debt-laden neighbour.

"We will look at Dubai's commitments and approach them on a case-by-case basis,” a government official told Reuters by phone.

“It does not mean that Abu Dhabi will underwrite all of their debts."

Abu Dhabi, which pumps 90 percent of the oil that make the UAE the world's third-largest oil exporter, has already provided $15 billion in indirect support for Dubai through the UAE central bank and two private Abu Dhabi banks.

"Some of Dubai's entities are commercial, semi-government ones. Abu Dhabi will pick and choose when and where to assist."